While stocks provide the potential for steady gains and dividend payments, the stock market can also be volatile at times.
In 2020, for example, the markets have seen some of their fastest and steepest declines in history, and at the same time also experienced their biggest single-day gain ever.
This kind of extreme volatility might make new investors uneasy, as it should.
Fortunately, there are a number of ways to position investments in a way that can shield them from the worst effects of extreme volatility. It may even be possible to profit from such uncertainty.
Risks and Rewards of Safe Haven Investments
The more conservative and risk-averse an investor feels, the greater their allocation to safe haven assets tends to be. These assets are thought to be low-risk, low-reward under most circumstances.
The goal of safe haven investments isn’t to produce a significant return. Rather, the goal is first and foremost to preserve wealth, i.e., not lose money.
However, due to investor psychology, safe havens can appreciate during uncertain or volatile times, as investors sell risk assets and buy safe haven assets.
As an example, look at the price of gold in 2020.
Gold and Related ETFs
Gold has performed very well so far in 2020. The same has held true after most times of crisis, as investors see physical gold as one of the greatest and most tried-and-true safe haven assets.
For thousands of years, cultures around the world have used gold as money. Central banks that create the world’s fiat money supply hold many tons of gold in their vaults.
Gaining exposure to gold can be accomplished in a variety of ways, including:
• Acquiring physical bullion (coins and bars) from a reputable dealer.
• Opening an account with a reputable company that holds gold in overseas vaults.
• Buying gold mining stocks and ETFs.
All of these methods have their benefits and drawbacks. The simplest method for investors using a traditional brokerage account might be to invest in gold mining securities.
Historically, the gold mining stock sector tends to rise by about four times when the price of gold goes up (although past performance does not guarantee future results in this or any asset class).
Researching and picking individual gold mining stocks might prove difficult and risky for most investors. Fortunately, there are investment vehicles that can provide exposure to the sector.
Like most other safe haven assets, gold is typically thought of more as portfolio protection than a quick money-making investment. But in times of great crisis, gold has the potential to provide both solid protection, as it appears to be doing thus far in 2020.
Bonds and Related ETFs
Bonds are also thought of as one of the ultimate safe haven investments.
Government bonds such as US Treasuries are backed by the full faith and credit of the US government. For this reason, Treasuries are thought to be virtually risk-free. The only way for them to result in a loss would be for the US government to declare bankruptcy.
Still, bonds are not always a guaranteed win, either. If their yield doesn’t beat the rate of inflation, then bonds are not profitable, although they should still perform better than holding cash alone.
In 2020, bond yields have reached record lows, as many spooked investors have fled to safety (a bond’s yield has an inverse relationship to its price, so when the price goes up, the yield goes down).
There are a number of investment vehicles on the market that make it simple for investors to gain exposure to this asset class.
To build wealth overtime, the option for dividend reinvestment also exists. A dividend reinvestment program (DRIP) allows earned dividends to automatically be reinvested into the same security.
Index Funds
While index funds are still fundamentally a way of investing in the broader stock market, they tend to carry much less risk than holding shares of specific equities.
Index funds can insulate investors from the worst effects of the wild swings of a volatile market. The tradeoff, of course, is that the rewards tend to also be more muted. Those seeking portfolio protection will have no problem with this.
An index fund keeps things simple and allows investors to keep money in the market without having to worry about volatility quite as much. Historically, markets have always risen over time. That means that for investors with a long-term horizon in mind, holding some index funds could make sense.
Bitcoin or Related Securities
Some analysts have lately put forth the case for Bitcoin as a safe haven investment. It’s a controversial opinion, one that not all analysts hold. Those who do not think cryptocurrency has reached safe haven status yet, still concede that the possibility is there.
Buying and holding Bitcoin may prove challenging for investors who don’t consider themselves tech savvy. Or, some may just prefer to house their investments in a traditional brokerage account. The analysts who are not sure about cryptocurrency being a safe haven at this time think investors will fall back on investments they are comfortable with, like dollars and bonds.
Something like Bitcoin is an opportunity traders refer to as having “asymmetric upside,” which refers to a situation where the risk/reward ratio can be more favorable than is common, meaning a small risk could potentially pay out huge rewards. Investors are cautioned to remember that past performance does not guarantee future results, and no one can predict market performance.
Cash In High-Yield Savings Accounts
Finally, it might be best to hold some amount of cash during uncertain times as well.
While cash doesn’t yield much of anything in an era of central bank’s zero-interest rate policy (ZIRP) , it isn’t likely to lose more than about 2% per year due to inflation, although extraordinary situations can sometimes make this figure higher.
In addition, having some cash on the sidelines, or “dry powder” as traders like to call it, allows investors to take advantage of bargain opportunities when they arise.
If a stock or ETF an investor believes has strong fundamentals suffers a sudden drop in price, that may be a buying opportunity. Without some cash on hand, it becomes difficult to take advantage of a situation like that.
Even more simply, having an emergency fund is widely considered to be an absolute necessity. Should the need arise, liquid cash might be the only thing that will suffice.
The Takeaway
Holding some safe haven assets may be a key way to make sure that wealth survives the test of time. People work hard for their money and they might want to shield some of it from risk assets.
Ultimately, it’s up to the individual to determine how much of their portfolio to allocate to safe haven investments and how much to invest in riskier assets. While all investments carry some risk, those described here are generally thought to be risk-off assets when kept as part of a balanced portfolio. For investors who are not sure what the right course of action for their specific financial circumstances may be, getting help from a financial professional might offer guidance.
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